This year has seen significant stock market volatility on both sides of the pond. A lot of shares suddenly look like they might be cheap.
In such a situation it can be tempting to dive into the market and start buying straight away. But is that wise as a way to try and build wealth?
Real cheapness is objective, not subjective
Especially at a moment like this when the markets are so turbulent, it pays to remember what we are really talking about when we discuss cheap shares.
Just because a stock price has fallen does not mean it cannot keep falling. Some shares tumble and look really cheap – but then just keep on heading down.
Look at the share price charts for Ocado, Aston Martin, or Diageo over the past few years (to mention just a few).
There were multiple occasions when each may have looked like a bargain compared to what they cost before – yet still went on to head further southwards.
The issue here is that cheapness is not subjective. Just because something costs less than it did before does not in itself make it cheap.
Instead, I see cheapness (and value) as objective.
Am I paying less for something than I think it is worth, when factoring in the opportunity cost of tying up my money in it and also allowing myself a margin of safety when valuing it?
As billionaire Warren Buffett says, price is what you pay, but value is what you get.
This market contains bargains – and value traps
So, I am not in a rush to invest just because markets have been heading downwards in recent weeks.
Current geopolitical stability and its effect on oil prices and inflation are wreaking havoc for some businesses. Indeed, that has already shown up in recent announcements from companies whose trade might seem to be a long way from the Middle Eastern oil markets, like pub owner J D Wetherspoon.
What might that mean for investors? Some shares that look cheap right now might end up being value traps depending on what happens to the economy in coming months.
But others could end up looking like real bargains.
I am not waiting to see whether prices fall further. Instead, when looking for shares to buy, I ask myself the same question I always do: can I buy into what I see as a great business at an attractive price?
I’m hanging onto what I think is a bargain
For example, one share I thought was a bargain when I bought it a few months ago is yoga apparel retailer Lululemon Athletica (NASDAQ: LULU).
After I bought, it moved up and I was sitting on a paper profit. But the share has sunk again and my position is now worth less than what I paid for it. Still, I have no plans to sell as I think Lululemon remains a potential long-term bargain.
A weak economy and lower consumer confidence could hurt discretionary spending. Lululemon’s North American business was already struggling to keep up with fashion trends, so the firm faces multiple risks right now.
Long term, though, its strong brand, reputation for product quality (with the odd well-publicised slip), and large customer base are strengths. Plus, it is growing international sales strongly.
